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Money Games: Tencent

Tim Merel investigates the biggest games company you may never have heard of... yet

As the business of videogames moves ever more into the spotlight, is pleased to bring you a new monthly column from IBIS Capital director Tim Merel.

Each month he'll be examining a subject or sector of interest, beginning here with China-based company Tencent - and why it could be the biggest videogames company you might not have heard of.

Who am I?

Let me start by apologising - I used to be a lawyer, then I worked for Rupert Murdoch... and now I'm an investment banker. But - I'm also a software engineer, I write adventure stories, and I play a mean guitar, so life is a balance!

We're starting my monthly column with a profile of the greatest games company you may not know, Tencent. "No!" I hear you cry. "Surely Activision Blizzard, Electronic Arts, Take-Two or Zynga is the greatest?" Well, this all depends on your perspective, and when your perspective happens to be money, things change.

So who is Tencent?

To explain the praise for Tencent, let's start with some data. And again, I apologise; I tend to use a lot of data. For the innumerate, please look away now.

  • China has 29 per cent internet penetration, but 382 million users.
  • China is forecast to reach 56 per cent internet penetration (754 million users) by 2015.
  • Tencent holds dominant or leading stakes in many Chinese online/mobile markets (IM, games, eCommerce, search, mobile services).
  • Tencent's Chinese games market share was 20 per cent in 2009, forecast to hit 27 per cent by 2012.
  • Tencent's market capitalisation - which is in the order of ¥241 billion ($35 billion) with an enterprise value of 35x 2009 EBITDA in August 2010 - was greater than Activision Blizzard, Electronic Arts, GameStop, Take-Two, THQ, Atari, Game Group and Ubisoft combined.

So what about Sony, Microsoft and Nintendo? Okay, so Tencent is about halfway between Sony and Nintendo's market caps, and nowhere near as large as Microsoft. But (a) we're talking about game software not hardware and (b) Sony and Microsoft do a couple of other things too.

Tencent's integrated model is where the market is headed

Tencent generates around a 50 per cent operating margin. Online/mobile games (MMO, board & chess, casual/social) generate more than 40 per cent of its revenue. Tencent's business model appears to be migrating from virtual items (higher Average Revenue per User) to subscriptions (short term revenue reduction, but lower volatility), which is a reversal of the trend they started.

Expect to see the same thing happening in Western markets in 12-18 months time, which is roughly the lag between China's pioneers and the West's followers.

Of great importance, Tencent has an integrated business model with upgrades and privileges across online, mobile and offline (not just games), delivering a significant advantage for customer acquisition, development and retention.

It capitalises on enhanced capabilities to cross-promote, upsell and cross-sell. Facebook could learn a lot from them about how to make even more money. avatar GamesIndustry International is the world's leading games industry website, incorporating and